An Unlikely Hero Takes a Stand Against Big Banks

By Neil Barofsky -
Mar 14, 2013

The decimation of mortgage
underwriting standards was one of the core causes of the
financial crisis as the Wall Street banks recklessly assembled,
packaged and sold bonds backed by fraud-riddled mortgages.

After the crisis, the private market for such mortgage-
related bonds understandably vaporized as once-bitten, twice-shy
investors steered clear of the financial products that had
caused such mayhem.

Alas, years of zero-interest-rate policy by the Federal
Reserve has yet again triggered a chase for yield, and in
response the banks are gingerly dipping their toes back into the
private mortgage-securitization pool. History won’t repeat
itself, right?

Well, not so fast. As with all things related to Wall
Street, it’s all about the incentives. And the individuals
behind the securitization machine before the crisis made a lot
of money. Like buy-your-own-island type of money. And when
everything collapsed, they largely kept that money. No
indictments, no handcuffs, no jail time and no significant
financial penalties for the architects of a crisis built on a
foundation of fraud (they were called liar loans for a reason).

Although the government has brought some civil cases, they
have been settled on terms that can only be compared to the
proverbial slap on the wrist, and we are reminded almost daily
that there remain banks that are both too big to fail and too
big to jail.

Civil Litigation

The one silver lining to this very dark cloud is that the
banks haven’t yet proved to be too big to nail, as the wronged
purchasers and insurers of their toxic bonds have been waging an
occasionally successful multiyear legal battle against the banks
and, indirectly, actually punishing them financially for their
misconduct. It, therefore, shouldn’t be surprising that, as the
banks re-enter the securitization market, their biggest concern
seemingly isn’t to ensure that they aren’t once again peddling
fraudulent products that might bring government scrutiny, but
rather to deal with private civil litigation.

So, as reported in the Wall Street Journal, they have
proposed stripping away investors’ ability to later sue them by
putting an expiration date on the representations and warranties
in the bonds and altering some of the presumptions when a
borrower defaults.

Put simply, the old bonds contained legal clauses in the
contracts that essentially said: “Hey, we promise that what we
say are in these bonds are actually in the bonds. And if not,
you can sue us.” The new bonds? “Good luck with that.”

As the Journal reports, however, the banks are facing a
most unusual obstacle in their plan to unleash what may prove to
be the next wave of ticking time bombs: the credit-rating
companies. Yes, the same ones that demonstrated before the
crisis that the only thing standing between a mortgage-related
bond and a AAA rating was a pile of bank money. They are now
apparently refusing to bestow such a rating on bonds whose
representations and warranties will expire like stale milk.

This is a problem for the banks because they need that
stamp of approval in order to persuade large-scale investors to
jump back into the mortgage-bond pool with them.

JPMorgan Chase & Co. (JPM), apparently outraged that a lowly
credit-rating company would dare to question one of its elastic
economic models, has publicly whined about the stance of one
such unidentified rating company. As a result, we are told,
credit will be restricted, the economy won’t recover, and
countless Americans will be deprived of the opportunity to help
inflate the next real-estate bubble.

Rater’s Courage

My response? Well, for the first time in my almost 43 years
on this planet, let me say this: Good for you, unidentified
credit-rating company.

Whether this is the result of some residual pride in your
work (unlikely), a deep sense of shame for your role in the
crisis (difficult to fathom), or fear now that the Justice
Department has filed a $5 billion lawsuit against Standard &
Poor’s for fraud (almost certainly), it’s nice to see someone
stand up to the bullies. Now let’s see how long it takes for a
rival rating company, fees in hand, to swoop to the banks’
rescue.

(Neil Barofsky served as the special inspector general in
charge of oversight of the Troubled Asset Relief Program and is
currently a senior fellow at New York University’s School of
Law. He is the author of “Bailout: An Inside Account of How
Washington Abandoned Main Street While Rescuing Wall Street.”
The opinions expressed are his own.)

To contact the writer of this article:
Neil Barofsky at neil.barofsky@yahoo.com.